The Lending category is one of the most basic and important pieces of the puzzle in any ecosystem. Besides Dex Catelogy, Lending contributes to attracting outside cash flows, and at the same time, it also provides a liquidity base and provides prime interest on more complex products such as synthetics, derivatives, options and margin.

The importance of Lending Catelogy is indisputable, therefore, we perform a strategic analysis of the four leading Lending projects in the industry in the current difficult market situation. These analyzes focus on the strategies the protocol has implemented, its effectiveness measured by TVL and the protocol’s Governance Token price. Finally, we will give some projections for their strategic trends.

How Lending Protocol Works

General Work Model

Lending Catelogy is a very active industry from the summer of 2020 until the beginning of Q4 2021. The most common operating model is shown in the figure below, in which:

1. The lender will deposit the assets they want to lend to the pool of Lending Protocol (1).
2. In order to borrow assets from Lending Protocol, Borrowers need to mortgage assets (2) with a value greater than the property they want to borrow, then they will be lent by Lending Protocol property according to Brower’s needs (3).
3. After using the loan, the Borrower will deposit the borrowed property with interest (4)  into the Lending Protocol so that can withdraw back to the collateral (5).
4. Thus, the interest earned from the Borrower will be deducted from the Lender when they decide to withdraw their savings from Lending Protocol (6).

However, if you look closely, the protocols in this Catelogy operate in two main forms: (1) Accumulation of lending assets into the same pool, or (2) separate loan-lending pools.

Characteristic

Most of the projects operate according to models (1), such as MarkerDAO, Aave, and Compound. The project using model (2) is Kashi (under Sushiswap).

About the characteristics: Model (1) helps the protocol to save Gas Fees, high liquidity and default risk is a common risk for the whole protocol. If an asset class defaults, all users share the risk. While model (2) separates lending/borrowing pools, in default, that pool will not affect the entire protocol, in return, the liquidity level is fragmented.

In this analysis, we focus on the most common (1) shape model for strategic analysis of Lending protocols.

Lending Industry Performance

Operational Status

In terms of cumulative revenue, MakerDAO is leading in their business as they hit almost $120M as of Jan 2021, followed by Compound with over $45M, and Aave over $43.5M. These are also the 3 Lending protocols with the largest TVL in the industry.

If we divide the revenue generation time into 4 stages, we find cyclicality in their business activities, specifically:

1. Phase I (Growth): MakerDAO has high revenue growth first (Growth in revenue is 59.8x), then Compound ( 75.76x), and finally Aave (483x).
2. Phase II (Decrease in Demand): All 3 protocols have seen slow revenue growth compared to Stage I for MakerDAO, Compound and Aave of 1.63x, 1.37x and 2.73x respectively.
3. Phase III (Relative Growth): During this period, MakerDAO continued to thrive with total revenue increasing 1.45x, Compound and Aave by 1.57x and 2.45 respectively.
4. Phase IV (Recession): This is the current phase where the revenue of the protocols has decreased over time, it has also reached the lowest level in Stage II for each protocol. The total revenue MakerDAO, Compound and Aave earned during this period were $41.7M, $8.5M and $11.3M respectively.

With the summary of each revenue generation stage as above, I find that MakerDAO is trusted by many users during the growth phase (Phases I and III), even during periods of reduced demand (Phases II and IV) when the revenue is reduced. Overall revenue generated from MakerDAO is still higher than the other two protocols.

Although we clearly see the cyclical nature of Lending Catelogy’s business, the short cycle lengths are different. Cycles coincide with the rise and fall of the overall market.

In the period from the beginning of 2021 until now, the revenue of protocols depends on the general market. The market grows, they generate more revenue and vice versa.

Next, we look at funding in the Lending and Borrowing operations of the protocols. In general, from Q4 2021 we see declines in both activities. Borrowing activity drops first, then Lending operation.

For Lending activity, the general decline starts on November 15, 2021. The declines from 11/16/2021 to 05/23/2022 respectively are -50.5% (MakerDAO), -48.6% (Aave) and -67.5% (Compound). These also decline the biggest drop since early 2021.

Particularly in the period from September 20 to November 15, 2021, Lending activity on MakerDAO spiked (129%) causing revenue in the corresponding period of this protocol to increase rapidly ( 1.72x). Starting 11/16/2021 up to now, all three protocols have experienced a drop in Lending activity.

With Borrowing, Aave, and Compound all seeing declines starting September 20, 2021, MakerDAO starting February 14, 2022. But MakerDAO also did not escape fate from the drop in business demand by the general market in early March 2022.

Compared to the peak for Borrowing activity of each protocol, the reductions were -23.4% (MakerDAO), -53.8% (Aave) and -75.9% (Compound).

In my opinion, the market will continue to reduce the demand for borrowing/lending until we have more new money from outside. What is the reason for this? The Fed’s prime interest rate is increasing in the past 2 months to reduce inflation, the Fed announced that it is expected to continue to increase until the end of 2022. This creates pressure in investment demand. in any financial market, at least until the Fed plans to lower interest rates again.

Lending Sector Index

An important ratio is Outstanding Loan/Lending Deposit which measures how much of a property is borrowed per loaned asset. This ratio also measures the performance of assets in the protocol, where 70-80% is considered good performance, above 80% is considered risky against liquidation, ultimately less than 70% is considered to be inefficient, and many assets are still available to lend while demand for loans declines.

The 70%-80% zone appeared in the period from June 21 to September 27, 2021, coinciding with the most active market time when the market cap was on the rise from $1.25B to $3B.

From September 20, 2021, this ratio gradually decreased to the lowest level of 41.53% (-50%) and is maintained at 67.44%. In my opinion, it is likely that this ratio will continue to decrease to around 40% in the near future when the demand for borrowing drops sharply and there is no certainty in the current macro situation.

However, if the cost of borrowing falls to a low enough level, it will stimulate borrowing again

Verdict

Currently, with the bear market sentiment, the performance of the lending category is decreasing sharply since November 2021. Industry information shows that the decline comes from the cash flow out of the Crypto Market and the decreation in demand in complex market conditions.

In my opinion, the lending category will still see a sharp decline in the medium term and we need a strong improvement in this defi product.

If you have any questions, comments, suggestions, or ideas about the project, please email [email protected].

DISCLAIMER: The Information on this website is provided as general market commentary and does not constitute investment advice. We encourage you to do your research before investing.

Marcus

Coincu Ventures